Morningstar | Cummins Reports Record Revenue in 2Q; Tariff Effects Likely to Hinder Margins
Excellent conditions in the second quarter for narrow-moat Cummins contributed to a quarterly record for revenue as robust demand for trucks, construction, and mining and power generation helped revenue grow 21% from the prior-year period to $6.1 billion. North America sales grew 22%, international sales increased 18%, and currency translation gains contributed another 1% to the top line. However, we believe the current operating environment will not be sustained for multiple years and expect any adjustments we might make to our fair value estimate as we update our model would be slightly downward.Operating income grew 23% to $722 million, and operating income margins expanded roughly 25 basis points to 11.8%. Management expects roughly $100 million in expenses related to trade tariffs and higher commodity costs for the remainder of the year. We will continue to monitor the expenses related to commodities, but believe underlying economic growth in multiple regions will outweigh the short-term headwinds and forecast full-year operating margins will be slightly below 12%. Engine shipments year to date are up more than 14%, which provides management ample flexibility when determining operating strategies.
In addition, Cummins completed an agreement with the U.S. Environmental Protection Agency regarding a recall that generated a pretax charge of $181 million. The recall of 500,000 trucks produced in 2010 through 2015 is due to a defective emissions control component that causes excess nitrogen oxide emissions; we do not expect Cummins' intangible assets moat source to be materially affected by the recall.
Management expects to complete an annual record for earnings in 2018 and intends to deliver 75% of cash flow from operations to shareholders in a mix of repurchases and dividends, which represents an increase from previous intentions of 50%. In the second quarter the company raised its dividend 5.6%, and we do not expect another rate hike this fiscal year.
Cummins is a diesel engine manufacturer. The company's segments include: Engine, which manufactures and markets a range of diesel and natural gas powered engines; Distribution, which is the company's primary sales, service, and support channel; Components, which supplies aftertreatment systems, turbochargers, transmissions, filtration products, electronics and fuel systems for commercial diesel and natural gas applications; Power Systems, which includes power generation, industrial, and generator technologies product lines; and New Power, which designs, manufactures, sells and supports electrified power systems ranging from fully electric to hybrid, along with components and subsystems.
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